In the second of this two-part series, Nick Dewhirst claims the investment industry has changed the way it makes decisions and assesses the impact on clients
When I started my career in the early seventies, private client brokers benefited from providing good advice because thatincreased their funds under man- agement and future commission flow, both directly for that client and from others whom the client might recommend. We practised the virtues of diversification and mentioned the performance of the FTSE 30 Share index in our portfolio reviews, but there was no suggestion that we should attempt to replicate its constituents or exclude shares because they were outside the index or indeed outside the country.
In those days institutional salesmen like me were paid commissions for selling good investment advice. The better our advice, the greater our share of the client's commission pot. However since the Big Bang in 1986, commission rates have been whittled down to negligible levels. Therefore the provision of investment advice is now merely a filler to retain client loyalty until the next IPO lands on the desk. Indeed salesmen are often expected just to report the analyst's views and often not even that, but only the company visits they have made.
Here too the alignment of broker and client interests has changed because payment by commission, determined by the client, has been replaced by salary and bonuses, determined by the firm, which may be motivated by the interests of several departments.
Typically their monthly reports recount the recent past, enthuse about some of stocks where the manager is already fully invested but remain silent on his predictions about the likely direction of the markets in which he is paid to invest. There are some exceptions, such as the team at Ruffer in London, which has racked up some of the best returns on global investments. However, these are rare.
Managers are motivated to retain the funds harvested by their sales team so as to earn annual management fees. Since financial companies rate steady ongoing fee income more highly than front-end and volatile commissions, the valuation of their businesses depends upon it.
If bearish, fund managers now seldom raise cash out of concern that their trustee might consider anything more than 10% on deposit as failure to observe the investment mandate. This is another reason that the big investment decision is pushed back to the customer.
Beauty parades are about the four P's - philosophy, process, performance and personnel, but predictions play no role in these marketing pitches. Judgement is made on the basis of historical tables of total returns and volatility in the past, with little regard to the likelihood that both may change in the future.
In my experience, when a great investment theme is exhausted, not only do future returns deteriorate radically from past performance but volatility increases as well. When such parades take place in buoyant markets, pension fund trustees often end up achieving the opposite of what they intended.
It seems that this dysfunctional arrangement is driven by the client's desire to achieve certainty in an uncertain world. Nowhere is that motive more powerful than in the provision of income when one is no longer able to work for a living. Nobody feels it more than trustees who are often drawn from the ranks of employees rather than experienced investors. They are not financially rewarded to assess risk but duty-bound to avoid it, in a world where every investment option either involves bets about the future, which is by definition uncertain, or an opportunity cost.
Funds of funds
Here one might expect that the practitioners focus on getting the big investment bets right - unconstrained by restrictive investment mandates or rear-view actuaries. However, much of this activity is focused on selecting managers rather than mandates.
The proportions to be invested in different asset classes are often treated as given, and the energy of the players is spent on reviewing managers. Just as the managers of funds compete in virility tests of how many companies they can visit, so the managers of fund managers compete in how many managers they meet. The building of inter-personal relations risks ossifying the process till it also represents another form of closet index-linking.
Independent financial advisers
All these problems are intensified, the less sophisticated the client and the smaller the funds at his disposal. Then the effort required to persuade someone to save for the future is only a justifiable business proposition if revenues are up-front, while costs are minimised by relying on investment input from free sources, that are only free in the sense that they subsidise other business activities, that is, selling funds.
Hence the popularity of the marketing message: "Buy for long-term growth". Not only does this justify paying top prices for whatever is most fashionable, and thus most easily sold to the ill-informed, but it also excuses early disappointing investment performance, on the basis that the holdings must recover because they represent long-term growth
• In his April column, Nick Dewhirst mentioned the retirement of Nils Taube at the end of last year. Taube has since launched a new venture, Nils Taube Investment Limited n
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